Dallas CPA Society Convergence gaps in M&A reporting May 4, different types of valuations. Jay Meldrum. Dave Klein.

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1 Dallas CPA Society Convergence 2012 Navigating the tax and accounting gaps in M&A reporting Welcome and today s speakers Jay Meldrum Jay Meldrum is a Principal in the Dallas office Transaction Services Group focusing on valuation advisory services. Jay has over 14 years of experience in valuation analysis and financial advisory work. He has performed numerous business valuation and intangible asset valuations for a variety of purposes, including purchase price allocations, mergers and acquisitions, tax reorganizations, corporate planning, litigation support, and bankruptcy assignments. Dave Klein Dave Klein is the leader of the Dallas office M&A Tax Group. Dave joined the firm in 1992 as part of the firm s tax staff and in 1996 transitioned to the area of mergers and acquisitions. As a member of the Firm s Mergers & Acquisitions Group, Dave works extensively with financial and strategic buyers and sellers in the mergers and acquisitions community. Dave has a wide range of experience, including due diligence reviews for both stock and asset acquisition transactions from both the buy and sell side perspectives, as well as transaction ti structuring t experience. 2 Welcome and today s speakers Jason Waldie Jason Waldie is a Director in the Dallas office Transaction Services Group. Jason has more than 13 years experience advising on technical accounting and accessing the capital markets. Jason specializes in advising on capital market transactions used to access the U.S. public and private securities markets, and has been involved in several transactions with premier companies in this sector. He is a leasing, business combinations and divestiture subject matter expert with extensive experience in a variety of sectors and his clients typically include both financial and corporate entities that he advises on multiple areas of US GAAP and SEC reporting. Today s agenda 1. When and why you need different types of valuations 2. Overview of M&A reporting differences 3. Pitfalls to avoid in the valuation process 4. Q&A 5. Best practices 6. Resources for more information 3 4 Part 1 When you need different types of valuations When and why you need different types of valuations Corporate event or transaction Financial reporting valuation needed? Tax valuation needed? Merger/acquisition* Impairment testing Migration of assets Internal restructuring Divestiture Equity method investment * Even when structured as a pure stock deal, tax considerations become critical for multinational transactions. 5 6

2 Audience question #1 For the transactions that your company has completed over the past 12 months or has planned for the near-term, are the majority: A. Domestic B. Multinational C. Unsure/not applicable When and why you may need valuations in accounting for M&A transactions Financial Reporting Business combinations under ASC Required to record most assets and liabilities at fair value - Generally results in increases to amortization and depreciation - Management and analysts very sensitive to accretion/dilution analysis - Goodwill impairment test planning 7 8 When and why you may need valuations in accounting for M&A transactions (continued) Audience question #2 Tax Reporting All transactions have potential tax implications Tax valuation determines step-up in basis for taxable transactions - No step-up in basis for carry-over transactions Determining tax value of individual intangible assets - Important for deferred tax reporting Standards for reporting asset value for tax purposes differ from accounting standards In your organization, how do you address the separate valuations required for financial reporting and tax reporting purposes for your recent or planned transactions? A. Tax department produces initial valuation used by finance department B. Finance department produces initial valuation used by tax department C. Tax and finance departments prepare independent valuations D. Tax and finance departments prepare integrated valuations E. Unsure/not applicable 9 10 Why doesn t one valuation serve all purposes? Audience question #3 Valuation analysis depends on the context in which valuation will be used - Valuation approach and result may differ depending on the purpose US GAAP, IFRS, US tax, Foreign tax Each have unique rules and requirements. Different standards with different definitions of value - Within the US tax code, tax valuation approaches and requirements differ based on the code section and transaction involved What structure would you estimate that most of the deals your company has completed over the past 12 months have taken? A. Mostly stock purchases B. Mostly asset purchases C. Equal number of both structures D. Unsure/not applicable 11 12

3 Part 2 3 key differences in purchase price allocation rules Overview of M&A reporting differences In theory, the transaction price of a deal is fixed But in practice, the transaction accounting for a deal will likely differ between financial reporting vs. tax purposes Tax and Book accounting are different Standards governing allocation methodologies differ Standards and definitions of value differ Purchase price allocations Book vs. tax differences Audience question #4 US financial reporting allocations Standards US tax allocations ASC 805, 810, 350, 820 IRC Sections 338, 754, 1060, 197 Rev Ruling 59-60, various other rulings and court cases Purchase price differences Excludes transaction costs Contingent consideration and liabilities may be measured at fair value Accounting purchase price includes deferred taxes All accrued liabilities are included Debt assumed measured at fair value Includes certain transaction costs Contingent consideration and liabilities not included No deferred taxes are included in the tax balance sheet Some accrued liabilities are not included Debt assumed measured at face value Have the M&A transactions that your company has completed or planned recently included contingent consideration (also known as earnouts )? A. Yes B. No C. Unsure/not applicable Transactions trigger different rules and procedures Purchase price allocations Book vs. tax differences US federal tax principles IRC 338, 1060 Total Consideration US GAAP ASC 805 Total Consideration US financial reporting allocations Allocation differences Goodwill is tested for impairment at the reporting unit level, but still needs to be assigned at a jurisdictional level for currency and deferred income tax considerations US tax allocations Generally need to value businesses and assets at the legal entity/jurisdictional level Legal Entity Legal Entity Legal Entity Class I Assets - cash Class II Assets traded securities, CDs Class III Assets trade receivables Class IV Assets - inventory Class V Assets fixed assets, catch all Class VI Assets - all 197 intangibles except those in Class VII Reporting Unit Reporting Unit Fair Value of Tangible Assetsxxxxxxxxxxxxxxxxxx Fair Value of Intangible Assetsxxxxxxxxxxxxxxxxxx Recognition and measurement of other items not recorded at fair value (examples such as deferred income taxes, pension plans, share based compensation, some contingencies, indemnification assets) Residual Goodwill (Including goodwill related to deferred tax liability) Goodwill can be allocated to the buyers preexisting reporting units Bargain purchase results in gain Valuation differences Fair value standard Market participant considerations Categories of assets (e.g., trade name) may be aggregated by reporting unit Tax amortization benefit always included in fair value, irrespective of transaction structure Goodwill is allocated only to the acquired entities Sequential allocation performed only to the extent of the purchase price (may result in limitation on intangible or other assets) Fair market value standard Willing buyer/willing seller Specific intangibles should be valued individually by legal entity but are often subsumed into goodwill Includes tax amortization benefit only to the extent amortization is deductible Class VII Assets goodwill and going concern value 17 18

4 Example Deferred income taxes Example Deferred income taxes (continued) Assume a US business is acquired by a US parent company for $1,000. The acquired business has 4 assets whose fair value is $1,000. For tax purposes, the seller s basis is $100 in these assets. In a taxable transaction, the acquirer would receive a step-up up for tax purposes of its basis from $100 to the $1,000 fair value. As a result, when applying ASC 740, no aggregate deferred income taxes would result, as the book and tax balances would be equal at $1,000. The opening book balance sheet would appear as follows: Net Assets $1,000 Cash $(1,000) In a non-taxable transaction, the acquirer would inherit the seller s s tax basis of $100, resulting in a book over tax basis difference of $900 in the aggregate assets. Assuming a 40% applicable tax rate, a deferred tax liability of $360 ($900 X 40%) would result. The opening book balance sheet would appear as follows: Goodwill $360 Net Assets $1,000 Deferred Tax Liability $(360) Cash $(1,000) Amortization periods for intangibles also differ between financial reporting and tax Audience question #5 Balance sheet account Purchase accounting step-up Amortization period (years) Asset deal Stock deal GAAP* Tax GAAP* Tax Trade names 450 Indefinite 15 Indefinite NA Technology 4, NA Relationships 2, NA Goodwill 3,950 NA 15 NA NA 10,400 GAAP acquisition accounting will be different, depending on the effect of deferred income taxes (see example on previous slide) There is only acquisition accounting (i.e., allocation of purchase price to assets) for tax purposes if structured as an asset deal (or 338 election) Difference between tax and book lives will adjust or create deferred taxes over time *For illustrative purposes only Companies tend to think about deals in terms of EBITDA -- before taxes. Have you ever had a tax "surprise" that negatively impacted the way that management evaluated the impact of the transaction? A. Yes, my predecessor really messed up B. Yes, but it was the financial reporting team s fault C. Yes, but it was the tax department s fault D. No, not on my watch E. Unsure/not applicable Part 3 Potential pitfalls of relying on financial reporting valuation for tax purposes Pitfalls to avoid in the valuation process Will get locked into a valuation analysis that does not meet deferred tax needs Need to make high level assumptions to meet needs Financial reporting valuation should not be used for transfer pricing purposes Allocation does not reflect legal and economic ownership Will not have information needed to assess transfers of IP in the future Purchase price allocation used in Section 338 election Miscalculating step-up in basis 23 24

5 Part 4 Part 4 Q&A Best practices/concluding remarks Best practices/concluding remarks Resources for more information: Carefully assess your tax and financial reporting valuation exercises to truly comprehend the full impact of your deal - Consider future tax restructuring that may require valuation of similar assets Rely on financial reporting and tax experts working together Perform book and tax valuations simultaneously (or at least understand implications of both before undertaking either) Contact us If you have any further questions about the topics covered in this presentation, please contact one of our presenters: Jay Meldrum Principal, Valuation jay.d.meldrum@us.pwc.com Dave Klein Partner, M&A Tax dave.klein@us.pwc.com Jason Waldie Director, Capital Markets and Accounting Advisory Services jason.waldie@us.pwc.com 29